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Let's say I have $100 in short term capital gains this year. I will need to pay taxes on this gains at the my ordinary tax rate (which we shall assume is 37%).

Let's also say there is a stock that has a dividend in December. It's $1000 stock and the dividend amount is $10. Let's also assume this stock has very low volatility.

So I buy 10 shares for $1000, collect the dividend, then sell the 10 shares for $990.

I've wiped out my short term capital gains. And now I only need to pay taxes on the dividend (which is a much lower rate than 37%).

What is wrong with this logic?

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(Assuming US tax jurisdiction based on use of $)

Unless I'm missing something, short-term capital gains and dividends are both treated like ordinary income and taxed at your marginal tax rate, so there is no tax advantage in converting short-term gains into dividends. The 37% you quote is the highest tax bracket and only applied to income (including capital gains and dividends) over $500,000+ (roughly).

A better option from a pure tax standpoint would be to realize long-term losses by selling securities that you have held for more than a year and are underwater. The long-term losses (which normally would reduce your tax by a lower percentage) can offset short-term gains that are taxed at a higher percentage, for a net tax benefit. This is referred to at "tax loss harvesting".

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    It appears that you are missing something, per BobBaerker (qualified dividends are taxed at a lower rate). – nanoman Apr 12 at 22:45
  • I think LT losses are first used to offset LT gains, and ST losses offset ST gains. You can only use them to reduce the other type if you have an excess of losses over gains within the same type. You can also use up to $3,000 in net losses to reduce ordinary income, the rest is carried forward. – Barmar Apr 12 at 23:00
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Adding to D Stanley's answer, dividends are either Qualified or Ordinary. Qualified dividends are taxed at a lower tax rate. Ordinary dividends are taxed as ordinary income.

In order for a dividend to be Qualified it must be:

  • issued by a U.S. corporation, by a foreign corporation that trades on a major U.S. exchange, or by a corporation incorporated in a U.S. possession.

  • The shares must have been owned for more than 60 days of the "holding period" which is defined as the 121 day period that begins 60 days before the ex-dividend date.

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    Can you include the implication for OP's question, since you seem to be making an important correction to D Stanley's answer? This means that generating a capital loss plus a qualified dividend is a valid tax strategy (if you have no other loss harvesting option and can accept the risk of holding for 60 days), right? – nanoman Apr 12 at 22:38
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Assumes United States tax rates (no country specified, but dollar sign ($) used in question)

What is wrong

  1. Your biggest problem is that you have $100 in short term capital gains. Avoid those when you can, since you don't seem to currently have existing losses to realize against them.
    Hold everything (that you can) 12 months so you are paying the long term capital gains rate instead of the short term rate.

  2. Creating a loss to offset a gain is almost always a bad idea.
    Yes, I saw that the dividend offsets the loss - doesn't change my advice.

  3. You don't specify that you'll buy the dividend in time to get the good rate.

  4. 37% is too high for your assumption.
    (If you are adding your state income tax rate to get up to this number... you shouldn't)
    37% is probably 60%-70% higher than the rate you should be using.

    • If you make $100k with $10 in itemized deductions your overall rate is in the low 20%'s
      (22 is 67% less than 37).
    • If you are making more than $200k, you should probably have a tax adviser
      your income is still less than half way to the max 37% marginal tax rate.
    • If you are making more than $500k, you should already have a tax adviser - who can teach you that... although you are actually in the 37% tax bracket... you aren't paying that much overall because the fist $500k is taxed at lower rates.
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    "although you are actually in the 37% tax bracket... you aren't paying that much overall because the fist $500k is taxed at lower rates." But the OP is discussing an attempt to avoid tax liability by cancelling, which by definition refers to the marginal tax rate. – Acccumulation Apr 12 at 16:58
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    Why shouldn't he add in his State income tax rate? And see Accumulation's explanation for why only marginal tax rates matter when you are comparing strategies. – David Schwartz Apr 12 at 17:11
  • Whether state tax should be considered depends on whether the state taxes dividends less than ordinary income. California does not, so converting ordinary income to dividend does not impact state tax. – Ross Millikan Apr 13 at 5:02
  • @RossMillikan Thanks for that! Also the question is useful to more people if state tax is not included in the rate. – J. Chris Compton Apr 15 at 16:26
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With stocks of individual companies, except for REIT's and BDC's, a dividend earned in one year but with a payment date in the next year is then taxed in the year paid. So buy this situation the day before the ex-dividend date and sell on the ex-dividend date as expecting the security to drop by the amount of the dividend. A capital-loss is realized in the current year while the dividend earned is realized in the next year.

However, buying a security the day before the ex-dividend date and selling on the ex-dividend date is a significant bet on the next day's market open.

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